Why Raising Interest Rates Can Help Suppress Inflation?

Over the past considerable period, the United States has been consistently raising interest rates with the aim of curbing inflation. Throughout this process, it can be observed that, although inflation data in the United States did not decrease rapidly, at least the upward momentum was contained.

So, why can raising interest rates curb inflation？ Let's briefly discuss this today:

How does inflation occur？

The fundamental reason why inflation occurs is that there is too much money supply, which is what is called “flooding the market with money”! Money represents purchasing power. When the money supply increases, the purchasing power of the whole society rises, consumption and investment increase, and price hikes become inevitable. At the same time as consumption demand increases, it will also stimulate producers of goods to increase investment in order to expand production capacity, thus leading to an increase in demand for raw materials and causing prices of raw materials to rise. This in turn drives up production costs of goods.

Ultimately, this forms inflation!

One of the purposes of interest rate hikes: Curbing consumption and investment!

After interest rate hikes, consumption can be restrained in two aspects:

1. Having money in the bank to earn higher interest will curb the desire for consumption.

2. Higher interest costs on borrowing for investing or consumption.

As long as consumption and investment are curbed, inflation can then also come down.

Second purpose of interest rate hikes: Appreciating domestic currency

After interest rate hikes, it pushes the appreciation of domestic currency against foreign currencies, enhancing the purchasing power of domestic currency on imported goods.

With the lowered costs of goods imported from foreign countries, the sales prices of these goods domestically can also come down, thereby driving down overall inflation levels.

Therefore, interest rate hikes whether externally or internally, are helpful in curbing inflation.

1. Interest rate hikes can curb consumption and investment, thereby resisting inflation;

2. Interest rate hikes can increase purchasing power of imported goods, thereby resisting inflation.